American Electric Power Raises Dividend 5.7%… What Now?
Summary For a utility, AEP’s record of dividend hikes is impressive. However, I suspect growth will be smaller in coming years as the ‘shale boom’ comes to a screeching end. At this time, I believe it’s best to stay on the sidelines on AEP. As a dividend investor, I tend to like utilities. But ‘climate change legislation’ has kept me away from most utilities. Solar and wind energy are expensive relative to fossil fuels. While utilities may ultimately pass those costs on to consumers, utility companies will have to invest a lot of money into new transmission and generation infrastructure. That means lots of new debt, with no significant demand growth: A very bad combination. When I look for utility companies, I look for ones that operate in states which have minimal or no ‘renewable energy mandates.’ I therefore tend to stick with US-based utilities because the US has some of the most reasonable energy policies of the developed world. I also tend to stick with select states where mandates are the lowest. American Electric Power (NYSE: AEP ) is one of the utilities I like. It operates mostly in Ohio, West Virginia, Texas and Oklahoma. While AEP has been increasing its renewable share of power, the numbers remain quite reasonable. Have a look. (click to enlarge) Courtesy of AEP Investor Relations. Even by 2026, only 15% of AEP’s total generation will be from ‘renewable’ energy sources. That’s pretty good. Of all the country’s utility providers, AEP’s generation is among the most economical. Back on November 6th, AEP paid a dividend of 56 cents, which is 5.7% higher than the previous quarterly dividend. For a utility, that’s quite an impressive growth record. That dividend growth has been mirrored by earnings growth. Between last year, this year and next year, AEP expects 4%-6% earnings growth, and the company is making good on that promise thus far. (click to enlarge) Courtesy of AEP Investor Relations. Where is that growth coming from? Well, it’s coming from capital investment, ‘rate recovery’ from investment in fully-regulated assets, and also cost savings. Each account for a good part of AEP’s earnings growth. Courtesy of AEP Investor Relations. A big advantage that AEP has lies in its location. AEP operates in the Eagle Ford, Permian, Marcellus and Utica shales. These territories have been hot-spots for growth over the last few years. Have a look. Courtesy of AEP investor relations. As you can see, industrial load growth in shale areas has far outpaced the rest of the company’s industrial base (and, indeed, the rest of the country in general), even though crude prices have fallen by 60% and rig counts have dropped by over half. This juxtaposition exists because the number of wells drilled per rig has increased dramatically, and the build out of midstream infrastructure has lagged behind the drop in activity. So, does the ‘shale boom’ live on? I don’t think so. Judging from both the comments and actions of OPEC kingpin Saudi Arabia, it really looks as if crude oil prices are going to stay low. But will production in these regions continue to remain stubbornly high? I really don’t think so. In 2016, the hedges of most shale-based E&Ps will roll off. This will ultimately lead to smaller lines of credit, and much less access to capital for these E&Ps (junk bond yields have risen sharply). With credit markets squeezed, I believe that small-sized and even medium-sized shale drillers will find it difficult to continue drilling at some point next year. Energy activity is lagging behind the oil price, but that drop is already coming. Therefore, I really believe that AEP will find it shale-area industrial growth coming to a halt next year. There’s a good chance it could even go negative. Courtesy of AEP Investor Relations. In fact, we can already see that industrial sales growth in shale regions has already pulled back significantly over the last few quarters. Expect much more of this. All things considered, earnings growth is probably going to slow down as a result of this. By how much is difficult to estimate. However, as the energy crisis deepens and takes a bite out of the economies of Texas, Ohio and Oklahoma, overall employment and GDP numbers in AEP’s service areas will underperform the rest of the country. In fact, that’s already begun to happen. (click to enlarge) Courtesy of AEP Investor Relations. Overall, AEP’s total electricity sales are scheduled to increase 0.6% in 2015, and that should translate to 4%-6% earnings growth. Next year, and indeed the years after, will be more challenging as long as crude oil prices remain low. While low oil prices are good for the country as a whole, they do effect AEP’s service areas. That is apparent when looking at the above right chart, where ‘AEP West’ represents both Texas and Oklahoma. Going forward I expect to see considerably slower EPS growth; perhaps something more like 2% or even less, because AEP’s operating territory is about to be hit hard, especially Texas. Overall, AEP will be fine because it is a diversified, regulated utility, but the company’s engine of growth is going to peter out soon. Therefore, I expect tamer dividend growth going forward. Is AEP a buy? Is AEP worth buying here? I would be cautious on this. According to data from FAST Graphs, AEP’s ten-year average price-to-earnings ratio is 13.7 times, but right now the company trades at 15.8 times. As a utility, AEP is also somewhat exposed to higher interest rates. If bonds trade lower, chances are AEP will follow. Right now, as with many stocks, caution is warranted with AEP. Those wanting to pick up a utility should instead look at Entergy Corp (NYSE: ETR ), which is benefiting from the petchem boom along the Louisiana and Texas coasts. That growth story is still somewhat intact.